Deck 10: The Financial Sector and the Economy

Question 1

The opening quotation of the chapter refers to Keynes's view of theory.
a. What do you think he meant by it?
b. How does it relate to the emphasis on the "other things constant" assumption?
c. Do you think Keynes's interest was mainly in positive economics, the art of economics, or normative economics ? Why?

Answer 1

Aggregate demand is equal to the overall demand of goods and services in an economy. Aggregate demand curve shows the relationship between the real GDP and price-level. Aggregate supply is equal to the overall production of goods and services in an economy. Aggregate supply curve shows the relationship between the real GDP and price-level. The intersection of AD curve and AS curve gives the equilibrium level of economy.
a.In the opening quote of the chapter, Keynes tries to tell that the theories in economics are not absolute and final, and they are just a medium to understand and analysis the economic activities and try to understand the reasons behind that.
b.Economics is governed by large number of variables at any point of time. Now, these theories which are explained in economics change or variate only few variables at a time to understand the effect and inter-relationships of these variables, and so other things are kept constant.
c.The quote of Keynes proves that he was interested in studying economics theories as arts of economics, because as per him these theories only help in understanding and help in formulating further thinking.

Question 2

Austrian economist Murray Rothbard has argued that government intervention during 1929 made what could have been a 1-year recession set off by the stock market crash into a 12-year depression. He believed that by creating confusing signals, government intervention kept investors from gaining knowledge of what investments to avoid.
a. Is Rothbard's explanation of the Depression consistent with the AS/AD model?
b. If one agrees with Rothbard, how would one's proposed policies to deal with recessions differ from those presented in the book? (Austrian)

Answer 2

Classical theory believing economists, believe that the economy should not have any intervention and economy with the help of price mechanism corrects itself. While Keynesian economist believe that proper intervention by authorities is needed to steer the economy at time of problems.
a.The explanation given by the Austrian economist is that government intervention is responsible for the recession transforming into Great Depression is consistent with the aggregate demand supply model. Rational expectations are an integral part of the model and the policies used by the government hit both consumers as well as suppliers which had made problem worse.b.People who agree with the Austrian economist would say that government intervention should not had been there, and the free market should had been given the utmost importance and then it would had solved the problem of recession much faster.

Question 3

Distinguish between a laissez-faire economist and an activist economist.

Answer 3

Here, as you know that, the Laisez-faire means leave the market alone. A Laisez faire economist follows the policy of let the market forces of demand and supply regulates the price mechanism. Classical economists believed that the market has the ability to be self-regulating through the invisible hand.An activist economist is one who believes in the government action. The activist economist like JM Keynes believed that government intervention is necessary during the times of recession.
A Laisez faire economist is more of a non-activist and observes the market interactions only. An activist economist wants the intervention to change the short run economic conditions. According to activist economist JM Keynes, if we do not do anything in the short run to improve conditions, we will not have suitable

Question 4

If the economy were close to high potential output, would policy makers present their policy prescriptions to increase real output any differently than if the economy were far from potential output? Why?

Question 5

In the 1950s, Michael Hubert King, an oil geologist, mathematically determined that when 50 percent of oil reserves have been extracted, annual oil output would inexorably decline. Hea. Use the AS/AD model and the production possibility curve to describe what will happen when oil production declines.
b. What will this do to the question of "distribution," both within and between nations? (Institutionalist)

Question 6

Classicals saw the Depression as a political problem, not an economic problem. Why?

Question 7

If the effective demand curve slopes upward, so that a fall in the price level causes a decrease in aggregate demand, how will your recommendation for fiscal policy be affected when the economy experiences a negative demand shock?

Question 8

Consider the following economic principles held by Classical economists: (1) Short-run problems are temporary glitches that are solved by the market; (2) The economy always returns to its potential in thea. What are Keynes's criticisms of these economic principles?
b. Why did he believe that they were wrong? (Post-Keynesian)

Question 9

Why, in principle, would one expect the AD curve to be vertical?

Question 10

Draw an AS/AD diagram from the Keynesian viewpoint. Assume the initial equilibrium in your diagram is just at the level of potential output. Then reduce the level of aggregate demand in your diagram. Now stare at this diagram.
a. Can you identify the excess capacity or depression in the diagram and what caused it?
b. What should be done to return the economy to a full employment level of output?
c. What does this exercise suggest about the distinction between economic theorizing (or positive economics) and policy recommendations (normative economics)?
d. Is one more value laden than the other? (Radical)

Question 11

What are five factors that cause the AD curve to shift?

Question 12

Explain how a rise in the price level affects aggregate quantity demanded with the:
a. Interest rate effect.
b. International effect.
c. Money wealth effect.

Question 13

What will likely happen to the slope or position of the AD curve in the following circumstances?
a. The exchange rate changes from fixed to flexible.
b. A fall in the price level doesn't make people feel richer.
c. A fall in the price level creates expectations of a further-falling price level.
d. Income is redistributed from rich people to poor people.
e. Autonomous exports increase by 20.
f. Government spending decreases by 10.

Question 14

What dynamic feedback effects can offset the interest rate, international, and money wealth effects?

Question 15

What are two factors that cause the SAS curve to shift?

Question 16

What will likely happen to the SAS curve in each of the following instances?
a. Productivity rises 3 percent; wages rise 4 percent.
b. Productivity rises 3 percent; wages rise 1 percent.
c. Productivity declines 1 percent; wages rise 1 percent.
d. Productivity rises 2 percent; wages rise 2 percent.

Question 17

Why is the LAS curve vertical?

Question 18

What will happen to the position of the SAS curve and/or LAS curve in the following circumstances?
a. Available factors of production increase.
b. A civil war occurs.
c. Wages that were fixed become flexible, and aggregate demand increases.

Question 19

If an economy is in short-run equilibrium that is below potential, what forces will bring the economy to

Question 20

Moore's law states that every 18 months, the computing speed of a microchip doubles.
a. What effect does this likely have on the economy?
b. Explain your answer using the AS/AD model.

Question 21

Congratulations! You have been appointed an economic policy adviser to the United States. You are told that the economy is significantly below its potential output and that the following will happen next year: World income will fall significantly and the price of oil will rise significantly. (The United States is an oil importer.)
a. What will happen to the price level and output? Using the AS/AD model, demonstrate your predictions graphically.
b. What policy might you suggest to the government?

Question 22

What fiscal policy actions would you recommend in the following instances?
a. The economy begins at potential output, but foreign economies slow dramatically.
b. The economy has been operating above potential output and inflationary pressures rise.
c. A new technology is invented that significantly raises potential output.

Question 23

Demonstrate graphically how a falling price level can destabilize an economy.

Question 24

Why is countercyclical fiscal policy difficult to implement?

Question 25

Why is knowing the level of potential output important to designing appropriate fiscal policy?

Question 26

In the late 1990s, a growing number of economists argued that world policy makers were focusing too much on fighting inflation. The economists also argued that the technical level of potential output had risen. Show their argument using the AS/AD model.

Question 27

Why is macro policy more difficult than the simple model suggests?